Phoenix Center for Advanced Legal and Economic Public Policy Studies and Lawrence J. Spiwak (1998). Utility Entry into Telecommunications: Exactly How Serious Are We? Lawrence J. Spiwak

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58 See, e.g., Michael J. Mandel et al., A Pack of 800 lbs. Gorillas: A Number of Major Corporate Players is Shrinking. Is that Bad?, Business Week (Feb. 3, 1997). Indeed, many conspiracy buffs now privately concede that there is actually stronger evidence to support the conclusion that there is a direct nexus between the rapid reconcentration trend in the U.S. electricity industry and Order No. 888 than to support the conclusion that Oswald did not act alone because there was another shooter at the “grassy knoll.”

59See Robert J. Samuelson, Telephone Straddle, The Washington Post (May 14, 1997) at A21; Easterbrook, supra n. 50 at 15-16, where Judge Easterbrook accurately observed, “[w]e should expect regulatory programs and other statutes to benefit the regulated group — they need not ‘capture’ the programs, because they owned them all along. The burgeoning evidence showing that regulatory programs increase prices for consumers and profits for producers supports this understanding.”; see also George Stigler, The Theory of Economic Regulation, Bell Journal of Economics and Management Science, Vol. 2, (1971) at pp. 2 21.

60See Reorienting Economic Analysis at 32; Market Reconcentration at 23-24.

61See The Search for Meaning, supra n. 2.

62See The Search for Meaning at 8; Reorienting Economic Analysis at 34, 36; see also Farmers Union Central Exchange, Inc. v. FERC, 734 F.2d 1486, 1504 (D.C. Cir.), cert. denied sub nom., 469 U.S. 1034 (1984) (The concept of “just and reasonable” must clearly be more than a “mere vessel into which meaning must be poured.”)

Readers should note that price regulation is generally appropriate only where one or more firms can exercise market power by raising prices above competitive levels. If price regulation is, in fact, warranted, however, then it does not mean that government suddenly has a “green light” to prescribe specific prices for goods or services. Indeed, if economic regulation is truly supposed to be a substitute for competition, then, just as in competitive, non-regulated markets, regulation should permit a range of prices for a particular product or service, each of which accounts for different consumer preferences and purchasing capabilities (i.e., volume discounts, superior service quality, etc.). For this reason, basic ratemaking principles instruct that there cannot be one, single, generic industry-wide price under the common “just and reasonable” standard. Rather, the “just and reasonable” standard only requires that prices fall within a “zone of reasonableness” — i.e., that these rates are neither “excessive” (rates that permit the firm to recover monopoly rents) nor “confiscatory” (rates that do not permit the regulated firm to recover its costs). They need not — just like caviar or Rolls Royce limousines — be “fair” or “affordable” for everyone.

Moreover, the regulator is also going to have to determine whether the firm(s) under its jurisdiction are single-output or, more likely in today’s era of “convergence,” multi-product firms. As such, whenever government attempts to define the “zone of reasonableness,” a primary focus on a multi-product firm’s aggregate profits is irrelevant. Rather, the appropriate scope of government’s inquiry should be whether the specific profits derived from providing regulated products and services (and not from ancillary businesses or investments) are the result of the regulated company’s ability to charge an excessive (i.e., monopoly) rate for the regulated product or service — i.e., the product or service over which it can raise price or strict output absent regulation. If the rate reflects the regulated company’s true costs of providing the regulated product or service, but government nonetheless believes that this J&R rate is “too expensive,” “unfair,” or not sufficiently “affordable,” then it is therefore wholly improper for government to require the regulated firm to “subsidize” the price it charges for its regulated service with ancillary profits just to make the rate more politically “affordable” or “fair.” When this occurs, “affordable” simply becomes an excuse for government to set unlawfully confiscatory rates instead.

As stated above, regulation is supposed to be the substitute for, and not the complement of, competitive rivalry. As such, regulators should attempt to set a rate that approximates the equilibrium price (i.e., where supply equals demand) that a rivalrous market would produce. Thus, if government truly wants to make prices for a “public” good or service more “affordable” — regardless of whether the end-price for this product or service is set by regulation or not — then government should focus its priorities on promoting entry and rivalry, such that firms will be forced to innovate and lower costs and, with such innovation and increased efficiency, force supply and demand to move down and to the right. If this shift occurs, then the entire “zone” should therefore also be forced down and to the right over time. So long as government maintains an “incumbent-centric” approach, however, it will provide firms no real incentive to innovate and lower costs and, as such, true de-regulation and competition will never occur.

63See Scherer & Ross, supra n. 55 at 9.

64See Market Reconcentration at 30; Reorienting Economic Analysis at 35 & n. 25.

65Hoecker Cites “Misconceptions,” Electric Utility Week, March 31, 1997) (emphasis supplied).

66Congress Should Mandate FERC Oversight of ISOs, Coalition Says, Inside FERC March 31, 1997 (emphasis supplied).

67FERC Chair Hoecker Delivers Scary Halloween Message for Industrials, Foster Electric report, No. 125 (Nov. 5, 1997) (emphasis supplied).

68See The Search for Meaning, supra n. 2 at 7 (emphasis in original).

69Id. at 7-8.

70Id. at 14; See also Easterbrook, supra n. 50 at 40 (“The principle that regulation must extend to catch all substitutions at the margin has a corollary: if you’re not prepared to regulate thoroughly, don’t start.”); See also Reorienting Economic Analysis at 35-36 & n. 33; Walter Adams, Public Policy in a Free Enterprise Economy in The Structure of American Industry, (7th ed.) (New York: MacMillan, 1986, Adams, Walter, ed.) at 405, where Adams argued that the primary purpose of economic public policy paradigms should be:

to perpetuate and preserve, in spite of possible cost, a system of governance for a competitive, free enterprise economy. It is a system of governance in which power is decentralized; in which newcomers with new products and new techniques have a genuine opportunity to introduce themselves and their ideas; in which the “unseen hand” of competition instead of the heavy hand of the state performs the basic regulatory function on behalf of society.

71See, e.g., Margie Hyslop, Electricity Dereg May Not Lower Rates, The Montgomery Journal (June 4, 1997) at A1; Hiram Reisner, Big Business Wins, Homeowners Lose Louisiana Competition Study Shows, Electric Utility Business & Finance (Oct. 7, 1996), reporting that in “terms of the economy as a whole, the benefits of expected lower prices for industrial customers do not offset the reduction in disposable income for consumers due to higher residential rates.” In fact, the state would “see an overall reduction in personal income, retail sales, tax revenues, and economic output” for several years. Funny, I though that the law is pretty clear on this point: The “public interest” may not be used to benefit a particular individual or group; rather, an agency’s actions must be consistent with the interest of “the public” as a whole. See, e.g., Northeast Utilities Service Co. v. FERC, 993 F.2d 937, 951 (1st Cir. 1993); see also n. 14 supra and citations therein.

72 Indeed, as the FCC recognized nearly twenty years ago:

Tariff posting . . . provides an excellent mechanism for inducing noncompetitive pricing. Since all price reductions are public, they can be quickly matched by competitors. This reduces the incentive to engage in price-cutting. In these circumstances firms may be able to chare prices higher than could be sustained in an unregulated market. Thus, regulated competition all too often becomes cartel management.

See Competitive Carrier Further Notice, 84 F.C.C.2d 445 at ¶ 26-27 (1981); see also Reorienting Economic Analysis at 35, & nn. 27-30 and citations therein.

73See generally, Phillip Areeda & Herbert Hovenkamp, Antitrust Law: An Analysis of Antitrust Principles and their Application (1995). Moreover, it is highly likely that this structure will bring an increased risk of antitrust scrutiny from enforcement agencies and other interested parties. Indeed, it is quite unclear how on one hand FERC basically believes it can force the industry to coordinate their pricing and access strategies (e.g., ISOs and power pools) yet at the same time apparently believe that they can “sprinkle” these activities with some kind of “antitrust immunity.”

74 See Foster Electric Report, supra note 67 (reporting that FERC intends to “expand upon certain themes” such as “considering whether to revise or enlarge the pro forma tariffs to allow for product and service innovations”).

75However, these “cheaper” sources of generation are often not the result of competitive operational efficiencies, but rather from a utility’s geographic location or load forecasts. For example, utilities which control sources of cheap hydro-electric power (e.g., the Pacific Northwest, Eastern Canada), have plenty of attractive excess power to sell. (Yet, despite the reality that Adam Smith proved that naked mercantilism harms consumer welfare, given FERC’s latest attempts to conduct foreign policy as well by prohibiting the Canadians to sell their cheap power in U.S. markets until they provide reciprocal Order No. 888-style transmission access to U.S. firms, see, e.g., Promoting Wholesale Competition Through Open-Access Non-Discriminatory Transmission Services by Public Utilities, 70 FERC (CCH) ¶ 61,367 (1997), it is unclear how cheap this Canadian hydro may actually turn out to be.) Similarly, those utilities which, because of recent load forecasts, have invested in substantial new, highly-efficient capacity designed to accommodate long-term demand, also have in the short-term very attractive excess generation to sell. Thus, if a significant wholesale customer bolts from the network, then a utility may actually have to close existing (and perhaps more expensive) plants as uneconomical. However, despite a prior finding by regulators that the utility prudently incurred the costs of these plants when the plants originally went on line, if the plants — with the customer’s departure — are no longer “used and useful,” then the utility will be unable to recover the remaining stranded (i.e., sunk) costs of the abandoned facility.

76However, because of the presence of exclusive franchises in the electric utility industry, antitrust courts have consistently recognized that “locational” retail competition is a flawed notion, because consumers generally do not choose where to live or do business based upon short-term electricity prices. See Lawrence J. Spiwak, Is the Price Squeeze Doctrine Still Viable in Fully-Regulated Energy Markets? 14 Energy L.J. 75 (1993).

77See n. 23 supra discussing various instances where power marketers are exiting the residential retail electric market in favor of the more profitable industrial market and (especially given the huge sums of money spent on marketing and false promises) is outraging residential consumers. See also Enron’s Pullout Shows Consumers Have the Real Power, Los Angeles Times (Business; Financial Desk, May 4, 1998) at D4 (“Let me get this straight. Enron says it can’t compete because of the 10% discount residential customers now receive on their monthly phone bills, yet Enron touts energy contracts for millions of dollars with some of the state’s large business and industrial customers.”); Bob Wyss, Cheap Power: Can the Little Guy Get Plugged In?, The Providence Sunday Journal (April 26, 1998) at F01 (“Nobody wants to be a sucker. But there has long been a suspicion that the residential electricity customer is the fall guy in all of this talk about competition.”) These reports should not be construed to stand for the proposition that targeting high-volume users over low-volume users is either “anticompetitive” or nefarious. It is not. All lawful businesses operate in this way. What these reports do indicate, however, is that it is possible to compete vigorously with integrity without lying to the American public. See, e.g., Quinn, supra n. 23 (Reporting that Atlanta-based Southern Co. had made a decision similar to Enron’s, but Southern initially focused on winning wholesale and large business customers “before embarking on an expensive sales campaign targeting residences. . . .”)

78Because of the huge volume and amount of power these industrial customers require (indeed, often exceeding the requirements of small munis), many people argue that these customers should simply be considered to be some sort of wholesale customer, such that public policy-makers can then honestly debate about the best way to facilitate true residential “retail” competition.

79Indeed, it is highly unlikely that a single residential customer’s ability to conveniently use the “Clapper” to “clap on” and “clap-off” their television set would make an equal contribution to help a utility balance its load.

80See supra n. 40.

81See, e.g., Sturdivant, supra n. 5; Hoecker Troubled by EEI Statements on Outage, Energy Daily (Aug. 27, 1997) (Reporting that Commissioner Hoecker criticized EEI’s statement that “there is a tension between coordination and competition, and [. . . that] the Commission’s rules [on competition] are pushing utilities to use [transmission lines] in ways they were not designed for.”); Hoffman, supra n. 25 (“While not a direct cause of the western outages, the transition to competitive electricity markets is expected to place further stress on the transmission network.”)

82Cf. Environmental Action, Inc. v. FERC, 939 F.2d 1057, 1061 (D.C. Cir. 1991), where FERC argued that it was permitted to exclude Qualifying Facilities (QFs) from transmission access conditions imposed under Section 203. The D.C. Circuit disagreed, holding that the Commission’s decision:

simply misconstrues the purpose of antitrust policy, which is not to make competitors equal, or to avoid all forms of advantage; the antitrust laws are for the “protection of competition, not competitors.” Brown Shoe Co. v. United States, 370 U.S. 294, 320, 82 S.Ct. 1502, 1521, 8 L.Ed.2d. 510 (1962). Competition is not valued for its own sake but because it is most likely to maximize the satisfaction of consumer wants. Had the FERC looked to the interests of consumers, rather than those of competitors, it would have gone a long way toward avoiding any error in its antitrust analysis. (Emphasis supplied.)

83 See Interview, FERC Chair James Hoecker, supra n. 45 (Retail competition “will develop much more swiftly on the electric side than it has in the city-gate market for natural gas” because “the technology already exists for customer choice at the retail level” and because there “is a greater political focus on competition and customer choice on the electric side.”

84See, e.g., News and Insight on Business in the Golden State Spotlight, LA Times (Feb. 23, 1998) at D2 (Reporting that while California retail wheeling experiment had to be postponed for at least three months to solve technical problems with hardware and software, officials were “confident” that they would not need a second delay); Electric Shorts, Foster Electric Report, Report No. 130 (Jan. 21, 1998) (Reporting that the United Kingdom’s Office of Utility Regulation recently decided to delay by eight months the full opening of the country’s retail electric utility markets, “citing the same computer glitches and other technical hang-ups that have forced California to delay the opening of that state’s markets to retail choice by three months”).

85See Peter Coy, supra n. 41. Just to recap, remember these disincentives include, inter alia: permitting utilities to recover only the embedded (rather than the incremental, forward-looking) costs of transmission facilities; having to provide rivals with “network” service (i.e., essentially having to provide multiple rivals — who are often geographically separated and therefore have very different demand and cost characteristics — with the de facto ability to dispatch their system and to have priority over native load requirements); and, as discussed supra, continuing residual “obligation to serve”/”carrier of last resort” responsibilities in this so-called competitive environment.

86See Lawrence J. Spiwak, Three Reasons Why Utilities Need Telecommunications Expertise — Whether they Like it or Not, Infrastructure, ABA Section of Public Utility, Transportation and Communications Law (Spring 1998). Indeed, any notion that “state-sponsored, managed competition” — i.e., when regulators order firms, as a condition of providing service, to lower their previously-approved just and reasonable rates to an apparently more “affordable” level — can either actually maximize consumer welfare or be sustained in the long-term is simply specious at best. The Search for Meaning at 7-8, 11-14 and citations therein.

87See, e.g., Town of Concord, supra n. 43, 915 F.2d at 25-26 (even if a utility’s anticompetitive conduct can successfully drive a rival from the market, a “utility [still] could not take over the municipality’s distribution area without the regulator’s permission.”); Cities of Anaheim v. FERC, 941 F.2d 1234, 1250 52 (D.C. Cir. 1991) (citing Town of Concord, the D.C. Circuit held that “even if a utility is able to squeeze a competing distributor out of the retail market, the utility still cannot take over the competitor’s franchise without approval from the local regulator.” Moreover, the court further held that because a retail distributor supplies “relatively immobile customers,” retail competition for electric power is “relatively static.”); West Texas Util. v. Texas Elec. Serv. Co., 470 F.Supp. 798, 819 824 (N.D. Tex. 1979) (no antitrust liability where actual and potential retail competition was de minimis). See also, Lawrence J. Spiwak, Is the Price Squeeze Doctrine Still Viable in Fully-Regulated Energy Markets? 14 Energy L.J. 75 (1993).

88See, Agis Salpukas, California’s Effort to Promote Plan For Electricity Is Off to a Slow Start, New York Times (Feb. 26, 1998) at D1, D6 (Energy marketer’s offer of a 10% rate cut was not the result of competitive savings, but rather was an automatic bonus — mandated by the California State legislature and paid for by a special bond issue — for every energy user who switched providers in the state.); Agis Salpukas, Utility Deregulation: Boon or Boondoggle?, New York Times (Feb. 1, 1997) (business section), reporting that consumers were not aware that most of the alleged savings resulting from New Hampshire’s retail-marketing plan were not the “result of free-market competition or any economies of scale that [a new entrant] might bring to bear on a regional market. Rather, they stem from state-mandated subsidies and from the willingness of . . .marketers to shave their profit margins to near zero to get a piece of the action.” (Emphasis supplied.) The article further reported that while the deregulation of the national market for electricity “might ultimately bring about lower prices in some parts of the country, the monthly bills of the 17,000 New Hampshire residents taking part in the current pilot program could bounce back up if the subsidies are phased out and [the] winners of the marketing battle reward themselves by taking a profit.” Readers should therefore not equivocate the pseudo-benefits produced by this “neo-competition” with the benefits produced by rivalrous competition — i.e., static economic efficiencies in the form of declining prices and dynamic economic efficiencies in the form of new products and services. See, e.g., Lawrence J. Spiwak, Reconcentration of Telecommunications Markets After the 1996 Act: Implications for Long-Term Market Performance, Antitrust Report (May 1997) at 17, 19 & n. 8 (explaining how the FCC’s Competitive Carrier paradigm successfully de-regulated the U.S. domestic long-distance market by creating a market structure conducive to competitive rivalry, under which carriers are forced to lower prices, innovate their services and, if necessary, actually pay people to be their customers.); see also Peter Elstrom, Slugfests: Reach Out and Pay Someone, Business Week (March 23, 1998) (Reporting that the “truce in the phone wars has broken down” as MCI Communications is accusing arch-rival AT&T of “flooding the market with checks to attract new customers” — estimated to be worth $368 million in January, up from $70 million a month in fourth quarter ‘97 — despite AT&T’s alleged assertions that it is curtailing the practice. According to MCI, “AT&T continues to pay customers to switch carriers, even though it says publicly that the tactic is misguided.” (emphasis supplied)); Scott Woolley, Get Lost, Buster — Lots of Companies Face a Peculiar Problem: How to Get Rid of Customers, Forbes (Feb. 23, 1998) at 90 (“What if cut-rate service drives off lower-paying customers? So be it. AT&T loses $500 million a year on its 15 million to 20 million ‘occasional communicators,’ who rarely make long-distance calls yet cost plenty to acquire, bill and service.”)

89See Reorienting Economic Analysis at 32-33.

90See 47 U.S.C. § 251 (as added by the Telecommunications Act of 1996).

91See 47 U.S.C. § 271 (as added by the Telecommunications Act of 1996).

92 However, the unfortunate fact that the FCC ignored the law and instead sought improperly to create a perpetual resale model (i.e., “trophy competition”) as political cover to pay for its schools and libraries program — rather than promote correctly tangible, facilities-based entry — is another story altogether.

93See Report of the Committee on Commerce, Science and Transportation, S. 652, S. Rep. No. 104-23, 104th Cong., 1st Sess. at 8 (1995) (“Senate Report”) at 7-8.

94Id. at 7 (emphasis supplied).




98What is really interesting to note is that while the 1996 Act is predicated on the belief that privately negotiated agreements — rather than government set prices terms and conditions — is the preferred mechanism to achieve meaningful interconnection, FERC is taking the exact opposite approach, even though the Federal Power Act dictates that rates, terms and conditions are supposed to be set in the first instance by privately negotiated agreements — not by government. See United Gas Pipeline v. Mobile Gas Service Corporation, 76 S.Ct. 373, 338-339 (1956); FPC v. Sierra Pacific Power Co., 350 U.S. 348, 352-53 (1956).

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